The ‘Beautiful’ Deleveraging

Saturday, August 18th, 2012

Submitted by Alex Gloy of Lighthouse Investment Management,

Some of my clients like to challenge my (admittedly gloomy) views, forcing me to think – which isn’t such a bad thing to do.

It started off with Cam Hui’s “A Dalio explanation of Evans-Pritchard’s dilemma“. After laying down his strategy on winning the game of Monopoly, Dalio goes on to model the economy onto the board game. So far so good.

Then, Dalio is quoted in a Barron’s interview, describing the current phase of the U.S. deleveraging experience as “beautiful”. He goes on to explain the three options for reducing debt: austerity, restructuring and printing money.

“A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.”

That sounds pretty good and makes sense. Or does it?

• I think Mr. Dalio would not be too upset if we labeled him a “Keynesian” (believing the government has to step in where private sector spending falls short).
• You could respond that it was Keynesian policies which brought us to the current situation in the first place (to which Keynesians will respond that their policies did not work out because there was not enough spending. Which is like saying “the kid is not behaving because you didn’t hit it hard enough“).
• Furthermore, how is the government sector on a different “planet” than the household sector? In the end, isn’t government debt (and hence fiscal deficits) supported and borne by taxpayers (read: household sector)? No sovereign entity in the world would be able to issue debt unless backed by taxpayers (or, for that matter, gold).
• As governments incur additional debt it is actually taxpayers’ future income that is on the block (as tax rates will have to go up to pay for additional debt service burden). Leverage is simply being shifted around. Oh, and for that time-shift argument (“tax receipts will have increased by the time the debt comes due”) – I believe it when I see it. There has been not a single country which has paid back its debt incurred under the fiat money system.
• If the future rate of inflation is below the interest rate paid on additional government debt, the net present value of deficit spending is negative (we are neglecting the argument over whether government can spend efficiently or not).
• Interest rates at issuance are fixed (exception: floaters). The decision whether to run fiscal deficits boils down to the following question: will future inflation exceed the interest paid (in order to devalue debt faster than accrued interest)?
• This makes the success of Keynesian policies dependent on elevated inflation. Governments are motivated, in a perverse way, to work towards reducing the value of money.
• This is in contradiction of central bankers’ (presumed) goal of preserving the function of money as a store of value, setting them up for a clash with governments (assuming they are not in cahoots anyways).
• However, there is no known case of a government successfully printing its way out of excessive debt (while there are plenty of examples for the opposite).
• It’s a lose-lose-situation: Should the government succeed in creating inflation, (1) financially prudent savers are punished, (2) low-income families are hurt (as they have no means to invest in assets benefiting from inflation) and (3) debt service costs are likely to increase as existing debt matures and needs to be rolled over.
• Should the government not succeed in creating inflation, future consumption will be burdened by additional taxes, lowering future growth and making excessive debt unsustainable.
• Will printing money “compensate” for money destroyed by debt write-offs? Turned the other way ’round, was money ever “un-printed” to compensate for money created from fractional banking and/or increased levels of debt?
• Cullen Roche of Pragmatic Capitalism states “QE [quantitative easing] doesn’t do much – it’s the great monetary non-event” (“Why QE is not working”).
• In the comments section of above article Cullen points out that

“It is flawed economic thinking to target nominal wealth. Stock prices are not real wealth until realized gains are taken. More importantly, stocks are based on the underlying value of the assets they represent. Pushing stock prices up does not make the companies more profitable. So hoping that people will spend more of their current income because of a false price appreciation in the market is a misguided policy.”

• So let’s take a look at Mr. Dalio’s “beautiful deleveraging”. Here’s US debt by sector:

Observations:

• Households are de-leveraging; so are financial corporations.
• This happens at the expense of the government sector, which continues to lever up.
• Total debt (government + households + corporations) is actually higher (by $800bn) than when the “beautiful deleveraging” began.

Let’s look at the numbers in percent of GDP:

• Peak debt-to-GDP has been reached in Q1 2009 for households, financial and non-financial corporations.
• Since then (latest data Q1 2012), households have de-levered by 11%-points of GDP (or $654bn).
• Non-financial corporations reduced debt by 3%-points (or $406bn).
• Financial corporations, however, de-levered by a stunning 33%-points (or $3,375bn).
• The flip-side of this: Federal debt-to-GDP increased by 27%-points (or $4,030bn).
• While the household sector has done “it’s thing” it usually does during recessions (de-lever), it become clear who the main beneficiary of additional government debt is: the financial sector.

Looking at quarterly changes in sector debt visualizes it nicely:

• Mr. Dalio and his firm (Bridgewater Associates, the world’s biggest hedge fund) are part of this financial sector. No wonder he describes this kind of deleveraging as “beautiful”.
• Mr. Dalio, who, according to a recent Bloomberg story (Connecticut offers millions to aid Bridgewater expansion), “was paid $3.9bn in 2011? is taking all kinds of tax breaks / “forgivable loans” to be lured to move from Connecticut to… Connecticut (at least UBS and RBS moved to the state when receiving tax breaks).
• I have walked through the waterfront area of Stamford. A lot of low-income families, often minorities, living in simple homes. The city is building new, expensive apartments for the new, well-paid arrivals, gentrifying the area.
• From Bloomberg:

“If the region [Fairfield county] were a country, it would be the world’s 12th-most unequal in terms of income, ranking just below Guatemala.”

• As for debt write-downs, this Zerohedge post speaks for itself: Deleveraging needed in next 4 years: $28 trillion

CONCLUSION:

While Mr. Dalio’s narrative reads well, it doesn’t stand up to common sense. Unfortunately there is lingering suspicion his views on government spending are a mere ploy to advocate for transferring even more debt from “his” sector onto taxpayers, while at the same time transferring taxpayers’ money to his firm via tax breaks.

Tags: Austerity, Barron, Board Game, Current Situation, Dalio, Debt Restructuring, Evans Pritchard, Fiscal Deficits, Government Debt, Government Sector, Household Sector, Incomes, Investment Management, Keynesian Policies, Keynesians, Lighthouse, Monopoly, Printing Money, Reducing Debt, Sovereign Entity, Winning The Game
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“Release the Kraken” (Hussman)

Monday, April 30th, 2012

by John P. Hussman, Ph.D., Hussman Funds

Over the past 13 years, and including the recent market advance, the S&P 500 has underperformed even the minuscule return on risk-free Treasury bills, while experiencing two market plunges in excess of 50%. I am concerned that we are about to continue this journey. At present, we estimate that the S&P 500 will likely underperform Treasury bills (essentially achieving zero total returns) over the coming 5 year period, with a probable intervening loss in the range of 30-40% peak-to-trough.

Why? First, with respect to 5-year prospective returns, it’s important to recognize that returns at that horizon are primarily driven by valuations – not the “Fed Model” kind, but the normalized earnings and discounted cash flow kind. Stocks remain strenuously overvalued here, and only appear “fairly priced” relative to recent and near-term earnings estimates because corporate profit margins are more than 50% above their long-term norm. Meanwhile, corporate profits as a share of GDP are about 70% above the long-term average. As I detailed in Too Little To Lock In, these abnormally high margins are tightly related (via accounting identity) to massive fiscal deficits and depressed household savings rates, neither which are sustainable.

Our projection for 10-year S&P 500 total returns – nominal – is about 4.4% annually, which is far better than the 2000 peak, far inferior to the 2009 trough, and save for the period before the 1929 crash, worse than any prospective return observed prior to the late-1990′s bubble – even in periods having similarly depressed interest rates.

Of course, rich valuations can persist for some time – predictably resulting in poor long-term returns, but often doing little to prevent short-run speculation and temporary gains. The issue is then to identify the point at which overvalued conditions are joined by sufficiently overextended conditions, and a sufficient loss of speculative drivers, to make rich valuations “bite” even in the shorter-term. This is where additional criteria come in, such as overbought technical conditions and extreme optimism in the form of low bearish sentiment, depressed mutual fund cash levels, and heavy insider selling. Presently, it doesn’t help that T-bill yields and long-term bond yields remain higher than 6 months ago, and we have signs of oncoming recession. This is particularly evidenced by collapsing economic measures in Europe, softening economic performance in developing economies including China and India, and jointly weak year-over-year growth in key U.S. economic measures such as real personal income, real personal consumption, real final sales, and reliable leading indicators from the OECD and ECRI, as well as our own measures.

The combination of rich valuations, overbought conditions, overbullish sentiment, and deteriorating leading economic evidence can still unfortunately persist for months before being resolved. But once the hostile syndromes we’ve seen recently have emerged in the data, attempts at continued speculation have amounted to playing with fire. Similar conditions have repeatedly resulted in disastrous outcomes for investors. It would be nice to be able to “time” these outcomes better. We haven’t found a reliable way to do so, and would still be concerned about robustness – sensitivity to small errors – even if we did. Yet even when unfortunate outcomes are not immediate, the fact that the S&P 500 has underperformed T-bills for 13 years is not very sympathetic to arguments that stock market risk has been worth taking overall, except in confined doses.

Tags: Corporate Profit, Corporate Profits, Discounted Cash Flow, Earnings Estimates, Fed Model, Fiscal Deficits, GDP, Household Savings, Hussman Funds, Kraken, Market Advance, Market Plunges, Model Kind, Profit Margins, Speculation, Term Earnings, Treasury Bills, Trough, Valuations
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David Rosenberg – “Let’s Get Real – Risks Are Looming Big Time”

Wednesday, February 15th, 2012

Earlier, you heard it from Jeff Gundlach, whom one can not accuse (at least not yet) of sleeping on his laurels and/or being a broken watch, who told his listeners to “reduce risk right now” especially in the frenzied momo stocks. Now, it is David Rosenberg’s turn who tries to refute the presiding transitory dogma that ‘things are ok” and that a Greek default will be contained (no, it won’t be, and if nobody remembers what happened in 2008, here is a reminder of everything one needs to know ahead of the “controlled”, whatever that is, Greek default). Alas, it will be to no avail, as one of the dominant features of the lemming herd is that it will gladly believe the grandest of delusions well past the ledge. On the other hand, they don’t call it the pain trade for nothing.

From Gluskin Sheff

LET’S GET REAL

We are constantly being told how much better the economy is doing. It’s incredible what the January employment report did to people’s perceptions of the macro landscape. It’s as if we were just transported to the mentality that prevailed this time last year. Below we chart out the YoY trend in core capex orders on a quarterly basis … the pace has slowed now for six quarters in a row.

The peak was 20.8% in the second quarter of 2010, but then again, that comparison was skewed by coming off the depressed 2009 base. In Q4 of last year, the trend moderated to 7.3% from 9.5% in Q3, to actually stand at its lowest level since the end of 2009. Food for thought.

Maybe the economy seems to be doing better because we have all adjusted our expectations so radically after being disappointed for so long — I mean — take 2011 as an example. A year that would normally see 5% real GDP growth for this stage of the cycle came in at a woeful 1.7%. This, despite a $3 trillion Fed balance sheet (triple its normal size), zero percent policy rates now for three years and now going on year number four of $1 trillion-plus fiscal deficits. Based on all this stimulus, if this were a normal post-recession recovery, GDP growth would be 8% right now, not sub-2!!

RISKS LOOMING BIG TIME

I remain amazed at how the consensus economics community is so certain the U.S. economy has suddenly hit escape velocity … again! The economy is on major duty life-support and yet the recession, we are told, ended nearly three years ago. And the best the economy can do is a trailing GDP trend of 1.7%. Go figure. Housing has bottomed, we are also told. No kidding? From a real GDP standpoint, residential construction has actually contributed to headline growth for three quarters in a row, and overall growth was still tepid.

In any event, in terms of peak contribution, it’s probably over. And yet economists talk about this as if it’s new and not already priced into the market. Of course auto sales are doing fine and this is a heck of a model year—this is an area where an argument can be made that there is some pent-up demand. But what is interesting is that miles driven are down nearly 1% on a YoY basis — buy more cars, drive them less. But autos are just 10% of total consumer spending on goods and the improving trend here masks a serious deceleration in service expenditures, which represent the bulk of household outlays.

One wild card is gasoline prices which are on a rising trend. Four bucks by May looks realistic and that alone would siphon around $70 billion from consumer pocketbooks right into the gas tank. Capital spending growth is following the pace of corporate profits on a downward trend to boot. The boost from inventory accumulation is behind us. Governments are bent on austerity — that remains a secular theme. The biggest hurdle ahead: the hit to the economy from a widening trade deficit. The numbers out for December we saw on Friday were the thin edge of the wedge — that widening occurred for different reasons (inventory-induced import boom). Wait until the European recession and Asian slowdown hits the export sector.

Tags: Avail, Balance Sheet, Big Time, Broken Watch, David Rosenberg, Dogma, Dominant Features, Employment Report, Fiscal Deficits, GDP Growth, Gundlach, Laurels, Mentality, Perceptions, Q3, Q4, Quarterly Basis, Real Gdp, Size Zero, Trillion
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Down With Europe (Roubini)

Friday, November 11th, 2011

by Nouriel Roubini, via Project Syndicate

November 11, 2011, NEW YORK – The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone’s problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.

For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone’s consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.

These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits. In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances.

The resulting build-up of private and public debt in over-spending countries became unmanageable when housing bubbles burst (Ireland and Spain) and current-account deficits, fiscal gaps, or both became unsustainable throughout the eurozone’s periphery. Moreover, the peripheral countries’ large current-account deficits, fueled as they were by excessive consumption, were accompanied by economic stagnation and loss of competitiveness.

So, now what?

Read the Complete Article

Copyright © Project Syndicate

Tags: Account Deficits, Competitiveness, Current Account, Divergence, Economic Stagnation, Excessive Consumption, Fiscal Deficits, Housing Bubble, Ireland Italy, Italy Greece, Last Decade, Last Resort, Market Access, Monetary Union, Periphery, Private Savings, Project Syndicate, Public Debt, Roubini, Surpluses
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QE and the “Crowding Out” of the Bond Market Vigilante

Friday, September 30th, 2011

Submitted by Global Macro Monitor

QE and the “Crowding Out” of the Bond Market Vigilante

We’ve updated our chart of the sources of financing of the U.S. budget deficit from the Fed’s Flow of Funds data released on September 16th.   The chart illustrates how the Fed and foreign central banks have been indirectly fully funding the  massive U.S. budget deficit for the last three quarters.   It will be interesting to see the data for the quarter ending today as no doubt there will be less yellow with the end of Q2 on June 30 and more “flight to quality” blue (domestic) and red (rest of world).

Ronald McKinnon, professor of international finance at Stanford University, has an excellent piece in today’s Wall Street Journal about the damage the Fed’s zero interest rate policy (ZIRP) is doing to the U.S. and global economy.  One of his main points is the Fed and other central banks, who are not yield sensitive,  have been financing the U.S. budget deficit and crowding out the now extinct U.S. bond market vigilante.

As you know the Global Macro Monitor is not a fan of ZIRP and believes it one factor that ails the economy not what will cure it.  We take comfort to be the same company of such an intellectual heavyweight as Professor McKinnon.

The professor makes several excellent points in his piece,

Without the [bond market] vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits.

 

…the vigilantes have been crowded out by central banks the world over.  [see the yellow/red bars in the chart]

 

Central banks generally are not yield-sensitive.

 

True, in the last two months, this “bubble” of hot money into emerging markets and into primary commodities has suddenly burst with falls in their exchange rates and metal prices. But this bubble-like behavior can be traced to the Fed’s zero interest rates.

 

Beyond just undermining political discipline and creating bubbles, what further economic damage does the Fed’s policy of ultra-low interest rates portend for the American economy?

 

First, the counter-cyclical effect of reducing interest rates in recessions is dampened…

 

Second, financial intermediation within the banking system is disrupted…

 

Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country…

 

Perhaps Fed Chairman Ben Bernanke should think more about how the Fed’s near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation’s financial markets.

Amen!

(click here if chart is not observable)

Tags: Ails, Bond Market, Budget Deficit, Central Banks, Commodities, Fiscal Deficits, Global Economy, Global Macro, Hot Money, Interest Rate Policy, International Finance, Last Two Months, Market Discipline, Qe, Ronald Mckinnon, Stanford University, Three Quarters, Vigilantes, Wall Street Journal, Zero Interest, Zirp
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Marketwatch Talks to Marc Faber

Sunday, August 21st, 2011

via Trader Mark, Fund My Mutual Fund

It’s starting to get all ‘bearish’ up in here, when Marc Faber stories top the most popular list at places like Marketwatch.  ’5 Money Moves Dr. Doom is Making’ was the top story yesterday and remains in the top 5 today.  Faber has had a very hot hand of late, coming into the month of August claiming ‘The Bear Market is Starting’ (video here) – the timing was impeccable – and then a week later looking for a very short term oversold bounce (link here) – again excellent short term trading as the 9th was Fed day and the worst of the lows before 100 S&P points of a bounce.

I always prefer Faber in video format for pure entertainment purposes, but he is always worth the listen in whatever format.  While his long term views are quite consistent (and doom-y) you can see the path he has prescribed that governments and central banks would go down… has become very accurate. 

By printing money,  the earnings power of the proletariat is diminishing, while the assets held by the wealthy are going up. And at the same time, the wealthy are outsourcing more and more production to China, to further rob the masses.

• Faber is to financial-market optimists what the Grinch is to Christmas. He doesn’t often like what he sees, and nowadays he finds even less to like about the world’s economic situation than he did in 2008 — as if that wasn’t bad enough.
• “Financial conditions are today worse than they were prior to the crisis in 2008,” he said in a telephone interview earlier this week from Thailand. “The fiscal deficits have exploded and the political system [in both the U.S. and Europe] has become completely dysfunctional.”
• Faber doesn’t take a contrarian stance in the strict sense; it’s more of a constant vigilance — capital preservation over capital appreciation — so that one can live now to fight for investment gains another day. (a viewpoint more investors – and managers -  should take!)
• “The way I look at it,” Faber said, “I am ultra-bearish about everything geopolitically. In an environment of money printing, we have to ask ourselves, how do we protect our wealth? … Where do we allocate the money?
• Good question, but in fact a fairly straightforward one if, like Faber, you believe that Federal Reserve policy is stoking speculation over savings and debasing the U.S. dollar, hyperinflation is a real possibility, the stock market’s recovery since 2009 has favored the rich and powerful, cash is trash, and gold and land in the countryside are the only true safe havens.
• “The Federal Reserve is a very evil institution,” Faber said with characteristic bluntness, “in the sense that they punish decent people who have saved all their lives. “These are people who don’t understand about stocks and investments,” he added, “and suddenly they are forced to speculate.”
• Such a miserly attitude can become a self-fulfilling prophecy. Faber noted that corporate earnings will likely disappoint stockholders across the board, including commodity shares, with the exception of traditional defensive sectors such as health care, consumer staples and utilities.
• Moreover, one of the main ways corporations are spending money — on mergers and acquisitions rather than on hiring and equipment — is ultimately inflationary, Faber said. “The corporate sector is not spending much money on capital investments and new investments — that’s why they have this huge hoard of cash,” Faber said. “There will be many more takeovers and industry consolidation in the years ahead. It destroys jobs, but this is what will happen. As industries consolidate, they get more pricing power, and the cost of living increases.”
• Of course, Faber points out, while such dealings might not be ideal for Main Street, it can sustain Wall Street, which leads Faber to a prognosis for stocks that may surprise the doctor’s patients. “I’m not that negative about equities,” Faber said. “If you’re bearish about the world, you’ll probably be better off in equities than in government bonds and cash.”

So batten down the hatches, double-check the locks and keep Faber’s to-do list handy:

1. Avoid Treasurys

• “It’s a suicidal investment to own 10-year or 30-year U.S. Treasurys,” Faber said. What about the Treasury rally in the wake of economic weakness, stormy stock markets and investors’ flight to safe havens?
• “What does a weak economy mean?” Faber said. “It means collapsing tax revenues. The deficits go up. You have to issue more government bonds.” The abundance of new debt would dilute credit quality, he added, only further sapping investors’ confidence in Treasury debt.
• “U.S. government bonds are junk bonds,” Faber said. “As long as they can print, they can pay the interest. But another way to default is to pay the interest and principal in depreciating currency.
• “For that reason I would advocate a wide basket of diversification out of dollar-based assets,” Faber added. “The dollar may rally somewhat, but clearly in the long run the dollar and other paper currencies — the euro is not much better — will have a depreciating tendency vis-a-vis honest money: gold and silver.”

2. Cash is trash

• Given his bleak assessment of the U.S. dollar, it’s no surprise that Faber doesn’t recommend holding cash as a long-term cushion against portfolio shocks.“It would be very dangerous to say ‘I don’t trust stocks, gold, real estate, I want to keep my money in cash.’ That’s a way to end up losing a lot of money,” Faber said.  Specifically, the problem in Faber’s view is the loss of purchasing power as inflation whittles away the value of money.
• “We’re in a paradoxical situation where under a traditional monetary system the safest places are cash, Treasury deposits, government bonds,” Faber said. Nowadays, he noted, “they have been made by monetization into the most unsafe assets from a longer term perspective.
• “Weak economies usually have higher inflation rates than stronger economies,” Faber added. “In weak economies you have loose fiscal policies and money printing. And the U.S. is the world champion in loose monetary policies. I don’t believe a single word of what the Bureau of Labor Statistics is printing about inflation figures. “Paper money has lost its value,” Faber said. “Hyperinflation is the pattern to come.”

3. Stocks offer some safety

• “I am not completely bearish about stocks,” Faber said. “If I have cash, government bonds and stocks, for the long term, I’d take stocks.”  Just not necessarily U.S. stocks.
• While Faber said the U.S. market is “oversold” and the Standard & Poor’s 500-stock index could rebound to the 1250 to 1270 range, he expects U.S. equity values to decline — though not in a full-blown capitulation.  “My assumption is that March 2009 was a major low, and that we will not go back below that low,” Faber said. “Can we go to 900 on the S&P? Yes.”
• But as the S&P 500 slides closer to 1000, the Federal Reserve could step in with a third round of stimulus for investors to cheer, Faber said.  Fed action, he noted, “may not lift stock prices to new highs, but it may stabilize them. If you print money, stocks will not collapse.”

4. Emerging markets will expand

• In contrast to his dim view of U.S. and other developed markets, Faber is downright sunny about investing in emerging nations. “I do not think that investors fully appreciate the enormous shift that has and is occurring in the balance of economic power from the Western world to emerging economies,” he told subscribers In a market commentary published in early August.
• This week, Faber reiterated his opinion that emerging markets will reward buyers over the long-term. “I happen to feel that somewhere in the world we can make 7% on equities for the next 10 years,” he said. “I can buy you a portfolio of high-dividend stocks in Asia that would have a yield of 5% to 7%.” Dividend predictability is one reason that Faber also recommends holding corporate bonds.
• Faber’s own stock portfolio is centered on dividend-paying Asian shares, particularly in Malaysia, Singapore, Thailand and Hong Kong. These include a variety of real estate investment trusts and utilities.
• Lately he’s also turned positive on Japanese banks, brokerages and insurance companies. “They have a better loan portfolio than the European banks,” Faber said of Japanese banks. “The banks in Asia are in a very solid position. All these are a play on the recovery in the stock market in Japan.”

5. Gold is worth its weight

• Gold blew through $1,800 an ounce on Tuesday, continuing its forward march as investors seek higher ground. Given his world view, Faber is convinced that the price of gold will continue rising and that any pullback is a buying opportunity.
• To understand why, you have to see gold like Faber does — as a currency, an alternative to the U.S. dollar, that will be increasingly in demand as the U.S. and other governments print more and more money.
• “The function of paper money is to facilitate the exchange of goods and services, to be a store of value and a unit of account — the U.S. dollar fails on all three,” Faber said. “Intelligent people, instead of holding cash in U.S. dollars with zero interest rates, why not hold money in gold and silver?”
• And as a currency, Faber said gold should be held in its physical form and not in shares of gold miners or even exchange-traded funds. That would rule out popular vehicles such as SPDR Gold Trust or iShares Gold Trust
• Be sure to store your gold in banks in Switzerland, London, Singapore, Hong Kong, Australia — just not in the U.S., Faber said. “Physical gold in a safe deposit box is the safest,” Faber added. “Forget about huge capital gains. I would look at capital preservation. I want to preserve my capital.

Copyright © Trader Mark, Fund My Mutual Fund

Tags: Bear Market, Capital Appreciation, Capital Preservation, Central Banks, Constant Vigilance, Dr Doom, Economic Situation, Entertainment Purposes, Fiscal Deficits, Gold, Grinch, Investment Gains, Lows, Marc Faber, Month Of August, Mutual Fund, Optimists, Printing Money, Proletariat, Strict Sense, Telephone Interview
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The 2011 Gold Season is Just around the Corner

Monday, August 1st, 2011

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

The ongoing debate in Washington prompted increased Fear Trade activity in gold this week. The issue over raising the federal borrowing limit caused the yellow metal to remain around its all-time high of $1,600 per ounce this week.

Gold has now increased for 124 months straight, says Deutsche Bank. The rally is in its 11th year, lasting nearly three times as long as other historical rallies going back to 1971. If the metal rose to $2,100 an ounce, it would represent the most powerful percentage increase in history, according to Deutsche Bank.

I believe what’s happening in the market today is a short-term driver of gold prices spurred by ETF investments. While Deutsche Bank believes a “market friendly resolution to the U.S. debt ceiling may trigger a short-term correction in the gold price,” fundamentals seem to be place to keep gold prices elevated over the long run. Even in many economic scenarios today, Deutsche Bank believes gold prices “appear irreversible.”

A more important driver that will keep gold prices elevated over a longer time period is the Love Trade. Marcus Grubb, managing director of investment at the World Gold Council (WGC), highlighted the significant aspects of this trend in his interview with Andrew Bell on the Business News Network (BNN). He says investors need to consider the issues outside of the euro zone, the debt-ridden countries and fiscal deficits.

More important to him is what he calls the “transfer of wealth from west to east” and the accumulation of wealth, particularly in China and India. This is what is driving the longer term strength in the gold price.

He states that the demand for gold is particularly strong in China: The country has a $3 trillion surplus, with some of it in gold, and he estimates that household wealth will most likely rise by five times. China and India also share a strong cultural affinity for gold as an investment and jewelry. For these reasons, Grubb believes this will drive gold demand.

To see the interview in its entirety, click here.

Merrill Lynch has found that there is a positive correlation between gold jewelry demand and rising with increasing wealth. The chart below shows that as the GDP per capital rises so does demand for gold.

September has traditionally been the beginning of the gift-giving season for gold. This is the time of year when gold jewelers are the busiest. The Muslim holy month of Ramadan begins in August and concludes with generous gift-giving in early September. Then it’s Diwali, known as “the festival of lights” in India, Christmas in the U.S., and Chinese New Year. The key to this seasonal strength over the past few years has been demand from China and India.

The spending spree has already begun in East Asia. In the WGC’s second quarter report, physical gold delivered at the Shanghai Gold Exchange was 14.65 percent higher than the previous year. Gold purchases also remained strong across East Asia, with tourists from mainland China buying gold in Hong Kong. In India, coin stocks, symbols of good fortune, were running low during the Akshaya Tritiya annual holiday in May.

Immediately following Marcus Grubb’s interview, I spoke with BNN’s Andrew Bell and expanded on the Love Trade season. We also discussed how today’s financial worries in the market place have caused a selloff in many equities and gold stocks. I talked about how many of these gold stocks are becoming extremely undervalued relative to the price of gold.

Click here to go to BNN’s website to see which stocks we discussed.

With approximately fifty percent of the world’s population controlling the Love Trade, we’re in for an exciting period. To kick off gold’s season, we invite you to join us on our upcoming gold webcast where we’ll discuss the themes above, as well as the opportunity in gold equities which we highlighted a few weeks ago.

Stay tuned for more details.

Tags: Andrew Bell, Chief Investment Officer, Debt Ceiling, Deutsche Bank, Economic Scenarios, Etf Investments, Euro Zone, Fiscal Deficits, Frank Holmes, Gold Price, Gold Prices, Gold Season, Grubb, Household Wealth, India, Ounce, Percentage Increase, Trillion, U S Global Investors, Wgc, World Gold Council
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Faber: Bernanke Doesn’t Understand Global Economics

Monday, July 18th, 2011

The following is a partial transcript of Jim Puplava‘s great interview on Financial Sense with Marc Faber, author of the Gloom, Boom & Doom Report. In a wide-ranging interview, they discuss Ben Bernanke, QE3, inflation, gold and much more. Click here to listen to the audio interview.

Jim Puplava: Marc Faber, the editor of the Gloom, Boom & Doom Report joins us on the program. And Marc, in a recent newsletter, you talked about getting together with some prominent economists; many of whom have been lifelong friends of yours such as Gary Shilling and David Rosenberg. Now, those two were deflationists. Two of you at the get-together were in the inflation camp yourself and Eddie Ardini. I’ve always found it amazing how economists can look at the same data and come to opposite conclusions. Marc, what is it in your backgrounds and line of thinking that makes you come to different conclusions?

Marc Faber: Yeah, that’s a good question. I mean, I think that deflationists, they all have families. They go shopping, their families go shopping, they pay educational cost, they pay healthcare cost, insurance cost and they see the fees on local government services increasing, taxes generally increases. Then I find this hard to believe that they would endorse the concept of deflation. But obviously, they may think that the economy may collapse and that as a result of that, we may have deflation and that, therefore, you should buy long term US government bonds. And my view is, particularly in the deflationist scenario, where you would have like Prechter said the Dow Jones below a thousand. In that scenario, you wouldn’t want to be in US government bonds and in cash for the simple reason that in that scenario, the fiscal deficits — in other words, spending — would exceed tax revenues even more than if you were actually optimistic about the economy.

Just consider — if the Dow Jones went below a thousand, what kind of an economic environment would we be in? We would be in a total credit collapse. We would be in a total economic collapse. And we would have a complete corporate profit collapse. And in a corporate profit collapse and in an economic depression, what do you think would happen to tax revenues? They would collapse, as well. And so the revenues of the treasury would decline very meaningfully and the fiscal deficit, which is now running, say, optimistically set at one and a half trillion. If you counted the unfunded liability stats are accruing every year. Probably the fiscal deficit is more like two to two and a half trillion dollars. But let’s say one and a half trillion dollars. If that happens, the Dow Jones below a thousand, corporate profits collapsing and revenues collapsing, then the fiscal deficit for sure would be two to three trillion dollars.

And in that environment, the quality of credit of the US — as was suggested by Moody’s yesterday — would decline and US government bonds, which I think are already today junk bonds, would go and yield much more than less than three percent of what they’re yielding at the present time.

So particularly, in the deflationary scenario, you don’t want to be in government bonds.

Jim Puplava: You know, I was reading that you got your PhD; I think it was at the age of 24, if I’m correct. How would you contrast the world as it existed back then, Marc, when you got your degree and the world today as it exists? And more importantly, working in the real world and running your own business, do you have a different view now of how the world works versus your days in academia?

Marc Faber: Well, first of all, I grew up in the fifties and sixties. I was born in ’46 so in the late fifties, I was, say, twelve to fourteen years old. And I have to say, in general, we were much more free than we are today. We had much more freedom to do things and to do stupid things. Today, everything is controlled — not only in the US, but also in Europe — they have become police state where everything is controlled and checked upon either by the police or the IRS or by the PSA or whatever it is. But you are restricted in every movement you make, basically.

Secondly, at the time I grew up, we still had fixed exchange rates. We had Bretton Woods — in other words, a quasi gold standard, which no longer exists today. And the ability to print money today and to run huge trade and current account deficits is much higher today than it was at that time. In ’71 under President Nixon on August 26^th, the US went off the gold standard and that led then to the inflation of the seventies and the gold price rising from thirty dollars to eight hundred fifty dollars.

Click here for the full transcript.

Source: Jim Puplava, Financial Sense, July 15, 2011.

Tags: Audio Interview, Ben Bernanke, Cost Insurance, David Rosenberg, Deflation, Dow Jones, Financial Sense, Fiscal Deficits, Gary Shilling, Global Economics, Gloom, Good Question, Government Bonds, Jim Puplava, Lifelong Friends, Local Government Services, Marc Faber, Partial Transcript, Qe3, Tax Revenues
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PIMCO Prepares For Global Inflation, Sees QE3 If “Recovery Sputters”

Wednesday, March 23rd, 2011

by ZeroHedge.com

As was first disclosed by Zero Hedge, PIMCO trimmed its Treasury holdings in February to zero. While many speculated that the reason is concern for global inflation, we now have the confirmation courtesy of a rhetorical Q&A with Saumil Parikh released by the Newport asset management giant. In a nutshell: “Setting aside immediate oil shocks, we believe global inflation has cyclically troughed and we see a secular upswing in inflation, which naturally will put upward pressure on interest rates. We see three key global factors as potentially adding to inflation over a long horizon: (i) The degradation of sovereign balance sheets and the structural inflexibility of fiscal deficits. (ii) Emerging markets used to export disinflation to the developed world, but over the secular horizon we see them as exporting inflation. (iii) As populations age, they tend to save less and consume more. Demographics may thus become an inflationary force globally, though possibly this risk will be balanced somewhat by demographics in emerging nations. In the near term, we anticipate most, though not all, global central banks are likely to err on the side of allowing inflation to rise above stated or implied targets during 2011. In the U.S., if the economic recovery sputters, the Fed could expand quantitative easing. But further deficit accommodation would pose inflation risks. Obviously nothing new here, and just a confirmation that in order to preserve the Wealth Effect, Bernanke will be forced to put the global Genocide [due to anti-revolution force in North Africa] (And Printing) Effect into overdrive.

Just released by PIMCO

Each quarter, PIMCO investment professionals from around the world gather in Newport Beach to discuss the outlook for the global economy and financial markets. In an interview, senior portfolio manager Saumil Parikh discusses PIMCO’s cyclical economic outlook for the next six to 12 months. Parikh, who leads the forums, is a managing director, generalist portfolio manager and member of PIMCO’s Investment Committee.

Parikh also comments on investment strategies that PIMCO is applying to manage risk and deliver returns amid global uncertainty and shifting growth dynamics.

Q: Could you discuss the economic recovery in the U.S. and whether PIMCO believes it will be a lasting rebound?

Parikh: I would first note that, as a baseline, PIMCO continues to foresee a multi-speed global recovery over the next few years, with advanced economies facing muted growth and unusually high unemployment, while systemically important emerging economies continue gradually to close the global income and wealth gap. This forecast is governed by more favorable initial conditions of debts and deficits in emerging markets as well as by the loss of capacity for fiscal stimulus in certain developed nations.

Having said that, there are certain cases where the cyclical outlook deviates somewhat from the secular outlook. Nowhere is this juxtaposition between the secular (three to five years) and cyclical (a year or less) more evident than in the U.S. The country is experiencing a cyclical economic rebound, but its strong durability is uncertain. While endorsing the resilience and innovation of U.S. citizens and the economy, there are concerns about the country’s ability to achieve in the short-term “escape velocity” due to the legacy of the global financial crisis and other structural headwinds.

Currently, governmental revenues are not growing fast enough to close deficits in a pro-growth manner, and the private sector continues to deleverage. As a result, the national savings rate has continued to decline as opposed to rise as is customary during a self-sustained recovery. Meanwhile, on the margin, political winds are changing and the next fiscal policy surprise could be contractionary – as opposed to the expansionary tax-cut deal of late 2010. And, further, we are concerned about the potential economic drag if oil prices remain elevated.

Bottom line: On a cyclical timeline, and also taking into account the external environment, we continue to forecast a 3.0%–3.5% real U.S. GDP growth rate for 2011, with risks tilted toward slower growth in 2012.

Q: And will the Federal Reserve extend quantitative easing?

Parikh: We do not anticipate that the Fed will add to the total quantity of Treasury purchases this year. If it were to change course, it could taper off the purchases (e.g., so instead of ending abruptly in June, the Fed starts buying less in April or May and stretches out purchases a few months beyond June).

Q: What is PIMCO’s outlook for Europe?

Parikh: The cyclical outlook for the eurozone and U.K. economies contrasts starkly with that of the U.S. Notwithstanding the favorable developments in Germany, several countries there face headwinds to growth via national austerity measures and the resulting fiscal drag over our cyclical horizon.

In our detailed forum discussion about the internal dynamics of Europe, the core economies are expected to achieve at- or above-potential economic growth due to strong initial conditions of competitiveness and a significant tailwind from emerging market external demand. Also, PIMCO sees a non-trivial probability of fat tails on both ends (positive or negative) for the European economy in 2011, depending on whether the sovereign crisis affecting Greece, Portugal and Ireland can be successfully quarantined before spreading to Spain and Italy.

Q: Turning to Japan, many of us have watched the incredible images of the events and the tragedy inflicted there. Certainly others are commenting on the humanitarian needs; perhaps you could discuss the impact on Japan’s economy and if there is hope on that front?

Parikh: The images are devastating and point to the massive calamities that have hit that country. Japan’s immediate focus is rightly on the enormous human suffering and on rescue operations, as well as containing nuclear-reactor risks.

Japan’s leaders have moved swiftly to stem fallout from the earthquake and tsunami on all fronts, including economic. Within days of the disaster, the Bank of Japan injected a record 15 trillion yen ($183 billion) into the world’s third-largest economy.

Japan’s economic growth rate will likely fall in the immediate aftermath of the natural disasters, but reconstruction activities should have a stimulative impact on growth over time. The loss of inventories and supply-chain disruptions could cause inflation to rise temporarily from very low levels.

Much will depend on the extent of the damage to Japan’s infrastructure. We are hoping for the best.

Q: Dramatic events are also sweeping the Middle East – is the region a threat to the global economic recovery?

Parikh: Certainly we are concerned that the sharp rise in global oil prices, and the threat that supply uncertainties could spur further increases, could lead to negative global growth consequences. A truly severe oil shock could shift our global GDP outlook from a soft landing to a more significant downturn with sharply stagflationary effects.

We continue, as with much of the world, to monitor and evaluate the situation closely. The risks are very asymmetric given the starting point of oil prices in 2011.

Q: Let’s shift to emerging markets. Does PIMCO still see them as drivers of global growth?

Parikh: We expect real economic growth in the major emerging economies of China, Brazil, Russia, India and Mexico to remain at a solid rate during 2011, but lower than 2010 due to fading monetary and fiscal policy tailwinds and some pockets of overheating.

In terms of composition, we see growth across the major emerging markets becoming more balanced, with less reliance on the inventory cycle as well as net trade and capital investments, and marginally more reliance on domestic final consumption as an engine for growth.

The main challenge for the major emerging economies in 2011 is managing the risk of greater overheating in the domestic economies. We judge idle capacity to be negligible and cyclical inflation and cost-push pressures on the rise to a degree that could threaten corporate profits, leading to a larger-than-expected slowdown. Once again, and similar to the U.S. outlook, the level and volatility of oil prices are a major cyclical risk to the emerging market growth outlook.

Q: What is PIMCO’s outlook on inflation and interest rates if the situation in the Middle East does not lead to a severe oil shock?

Parikh: Setting aside immediate oil shocks, we believe global inflation has cyclically troughed and we see a secular upswing in inflation, which naturally will put upward pressure on interest rates.

We see three key global factors as potentially adding to inflation over a long horizon:

• The degradation of sovereign balance sheets and the structural inflexibility of fiscal deficits.
• Emerging markets used to export disinflation to the developed world, but over the secular horizon we see them as exporting inflation.
• As populations age, they tend to save less and consume more. Demographics may thus become an inflationary force globally, though possibly this risk will be balanced somewhat by demographics in emerging nations.

In the near term, we anticipate most, though not all, global central banks are likely to err on the side of allowing inflation to rise above stated or implied targets during 2011. In the U.S., if the economic recovery sputters, the Fed could expand quantitative easing. But further deficit accommodation would pose inflation risks.

Q: Finally, could you discuss how PIMCO is applying its global outlook to its investment strategies?

Parikh: Let’s begin with inflation, which is a topic clients often ask us about, and how that applies to our investing decisions. Since we see a secular bias to global inflation, we expect fixed income yields to gradually rise; we believe the 20-plus-year secular duration tailwind that previously anchored portfolios is over.

So we have taken down duration in our strategies, moving to shorter maturity securities. For example, while we still have faith in the credit quality of U.S. Treasuries, we feel yields on longer-dated notes and bonds are likely to rise as the Federal Reserve ends its quantitative easing and investors price in growing inflation risks.

We continue to focus on attractive opportunities in other areas in the U.S. and across the globe, including foreign currencies and credits. There are lots of opportunities in this global marketplace. Finally, we are tempering our near-term enthusiasm for U.S. corporate bonds with a long-term outlook that the U.S. economy must eventually address fiscal deficits, rising rates and the potential for higher oil prices and those could all be negative factors for U.S. companies and the bonds they issue.

Thank you, Saumil.

Tags: Balance Sheets, Bernanke, Brazil, Central Banks, China, Disinflation, Economic Outlook, Economic Recovery, Emerging Markets, Fiscal Deficits, Global Economy, Global Factors, Global Genocide, India, Inflation Risks, Inflexibility, Infrastructure, Investment Professionals, Newport Beach, North Africa, oil, Oil Shocks, Parikh, Portfolio Manager, Russia, Upswing, Upward Pressure, Wealth Effect
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Gold’s Mania Phase Still Ahead

Wednesday, January 5th, 2011

After a $325 rise in 2010, gold bullion yesterday suffered its steepest one-day loss since July – down by $34 at the U.S. close after an intra-day low of -$40. The chart below shows the sell-off plunging the gold price down to right on top of its 50-day moving average. Also, the “triple top” could point to more downside in the short term.

Source: StockCharts.com

Does gold’s decline mark the end of the ten-year bull market? Or was it just a question of heavy profit-taking after performance gaming at the end of December?

BCA Research commented as follows: “The gold bull market has been driven by the potential inflationary implications of current large fiscal deficits and central banks that are prepared to stop at nothing to prevent deflation. It may be several years before developed-world real interest rates return to the norms of earlier decades, especially in the U.S. In this environment, gold will continue to be an excellent insurance policy and should continue to fare well when measured against the major currencies.

“In addition, it is hard to make the case that gold is currently a crowded trade. Many institutional and retail investors agree with the gold bull case but have been slow to act, even as their faith in conventional stocks and bonds has ebbed. Indeed, based on investor meetings and anecdotal evidence, we estimate that the average portfolio allocation to gold is around 1%. This suggests that there is plenty of pent-up demand which could still flow into gold and related shares.

“True, the gold bull market will proceed in instalments, not a straight line. It would not be a surprise to see gold suffer occasional selloffs of perhaps a few hundred dollars at a time during 2011. We would broadly view these selloffs as opportunities to boost core holdings. The bottom line is that gold is a potential mania candidate and expect good returns in this metal in 2011.”

I couldn’t have said it better myself.

Source: BCA Research, January 4, 2011.

Tags: Anecdotal Evidence, Bca Research, Bull Case, Central Banks, Conventional Stocks, Core Holdings, Downside, Fiscal Deficits, Gold, Gold Bullion, Gold Price, Instalments, Insurance Policy, Investor Meetings, Moving Average, Portfolio Allocation, Retail Investors, Selloffs, Stocks And Bonds, Straight Line, Term Source
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